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Is Largo (TSE:LGO) Using Too Much Debt?

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Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Largo Inc. (TSE:LGO) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Largo

What Is Largo's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Largo had US$15.0m of debt in December 2021, down from US$24.8m, one year before. But it also has US$83.8m in cash to offset that, meaning it has US$68.8m net cash.

debt-equity-history-analysis
debt-equity-history-analysis

How Healthy Is Largo's Balance Sheet?

We can see from the most recent balance sheet that Largo had liabilities of US$41.7m falling due within a year, and liabilities of US$6.54m due beyond that. Offsetting this, it had US$83.8m in cash and US$23.7m in receivables that were due within 12 months. So it can boast US$59.3m more liquid assets than total liabilities.

This surplus suggests that Largo has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Largo boasts net cash, so it's fair to say it does not have a heavy debt load!

On top of that, Largo grew its EBIT by 89% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Largo's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Largo has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last two years, Largo saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Largo has net cash of US$68.8m, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 89% over the last year. So we are not troubled with Largo's debt use. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example - Largo has 2 warning signs we think you should be aware of.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.

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